12 March 2002

Speech by the Economic Secretary to the Treasury, Ruth Kelly MP, on European Economic Reform, given at the Centre for European Policy Studies (CEPS), Brussels

I am very pleased to be here.

The Centre for European Policy Studies (CEPS) is an important institution. Think tanks can take the political process closer to the people or they can inform the debate at the highest levels. The CEPS manages to do both, making important contributions to the discussion on the big issues like democratic legitimacy and the future of Europe, as well focussed interventions on technical debates like labour market policy or securities settlement.

With the Future of Europe Convention underway and the Barcelona Summit later this week it is an exciting time for the EU. The Future of Europe Convention will help us establish the right institutional framework for an expanded Union and the greater involvement of our citizens in the decision making process. The Barcelona Summit will measure progress against the Lisbon agenda and speed the plough of economic reform.

It is Economic Reform that concerns us here today. Economic reform maters and it matters now. Economic reform maters because it is about increasing prosperity in Europe. If we could match the productivity and employment of the US, we would be better off by £5000 or ?8000 per person per year. Economic reform will not only make us more prosperous but also strengthen social justice by increasing levels of employment.

It is vital that two years after Lisbon the momentum behind economic reform is not seen to be slipping. Enlargement, an aging population and the introduction of Euro notes and coins all add to the sense of urgency that must inform our approach to reform of Europe's economies.

The Commission has done some solid work on the completion of the single market and the delivery of its benefits to our citizens. But there is more to be done.

The 1988 Cecchini Report set out in full the potential economic gains of the single market, arguing convincingly that completing it would raise GDP by 4.5% and create 1.8 million new jobs.

Yet by 1996 the boost to GDP ha been only 1.5% and just 1 Million new jobs had been created.

Now, it is 2002, and there is little to suggest we have realised even half the potential gains of the single market. On a simple measure, like productivity per worker, the EU still lags far behind the United States - recent studies suggest the gap is widening.

At Lisbon two years ago, European leaders acknowledged honestly that the Union was not living up to its potential. They set a ten-year goal to become the most competitive and dynamic knowledge based economy in the world, based on comprehensive reforms to product, capital, and labour markets.

We have done a lot:

5 million new jobs created;
Agreement on a new legal framework for telecoms; and
A start to reforming the state aid regime.

But we have a lot still to do and Barcelona is the place to do it.

The paper on ?Realising Europe's Potential? is our contribution to the debate: underlining our vision of the EU as a dynamic, job creating and socially inclusive economy; setting out the challenges we face to make that vision a reality. The paper provides a framework for analysis, splitting productivity growth down into five main ?drivers? - accounting for the differential between the EU and the US. It goes on to employ the ?drivers? as analytic tools to diagnose the problems and possibilities of the EU as well as suggesting policy solutions for Member States individually and the EU as a whole to consider.

This is not a preaching or prescriptive document; it is a framework for progress. Neither is it arrogance on the part of the UK, it is a frank recognition that we all have a lot to learn - each from each other - and that only by taking individual responsibility can we make collective progress.

The 5 drivers of productivity are:

More vigorous competition;
Increasing innovation;
Strengthening enterprise;
Improving our skills; and
Boosting investment and make best use of existing capital stock.

The capital market plays a key role in many of these areas. The creation of an integrated capital market is central to the wider economic reform agenda and to the realisation of the EU's productive potential.

Increasing competitive pressures and narrowing the significant price variations for everyday goods across the EU is a key objective. As Mario Monti has said, the ultimate aim must be to 'serve the European Citizen.? Competition ?is not an abstract concept, but has tangible effects on each single consumer.? Strong and efficient growth, driven by an effective competition regime, will ultimately deliver significant benefits.

The benefits we deliver to the citizen in terms of lower prices and higher quality must be the focus of our competition policy. In the UK we are working towards a strong independent competition regime, free from political influence. In the EU we must support the Commission's efforts to pursue a forceful, proactive, independent and economically rigorous competition policy.

Commission surveys regularly confirm a weak picture of competitive pressures. Prices of electronic goods differed between Member States by up to 40% and for food the difference was even more marked. This is an unacceptable state of affairs.

On competition, we propose:

Support for the Commission's competition regime;
Less but better state aid; and
Open markets - particularly in key areas like energy, transport, and communication.

The Competition regime needs to be based on the principles of independence, opposition to all forms of anti-competitive behaviour, strong deterrence, and adequate redress. We need to get Professor Monti and his people at DG Comp to send a strong signal to the markets in this important area.

Effective state aid is essential to a competitive and prosperous economy. Levels of State Aid have come down since the 1980s but at twice the level in Japan and four times the level in the USA they are still far to high.

Inappropriately directed state aid undermines competition, fairness and efficiency. Reform of the regime needs to be linked to the concept of market failure and the aim of structural reform - so the ?90 billion we spend each year can be reduced and targeted to better support our Lisbon objectives.

The third step towards enhanced competition must be opening markets in priority sectors. Reforming the Common Agricultural Policy, completing the single market in services, and opening network industries like energy, communications, and aviation, is high on the list of priorities. We hope there will be substantial progress at Barcelona.

An effective competition regime and open markets will support the second and third drivers of productivity - helping create an entrepreneurial atmosphere in which innovative companies can flourish and new ideas can be implemented. In March 2000 the EU had only 785 firms listed on small company exchanges, in the US that figure was 4800. No measure of innovation is entirely satisfactory but on this evidence the EU has a long way to go.

On any measure - creation, survival, or growth of new companies - the EU lags far behind the US.

To bridge the gap - encouraging entrepreneurs and incentivizing innovation - a strategic approach is required. To increase investment in innovation and entice entrepreneurs into the marketplace we have to:

Improve access to venture capital
Ensure regulation is well targeted;
Support small firms; and
Enhance Research and Development.

Entrepreneurs are important in any economy and there is a clear role for government in creating an atmosphere where they can thrive. The first step is to improve access to venture capital. Venture capital is valuable in itself and in terms of the managerial and technical know how that often accompanies it. Levels of venture capital are too low, hampered by the absence of a single European Capital market and the lower returns on investment that are the by product of inefficient and inappropriate regulation.

Good regulation can bring significant social and economic benefits - correcting market failures, enhancing public confidence, and improving quality of life without hindering economic growth. Bad regulation, unnecessary and inefficient, can have serious side effects - restricting competition, stifling enterprise, and deterring investment.

In recognition of this fact a number of Member States have moved towards a system of regulatory impact assessment - aimed at ensuring that the benefits of any new regulation outweigh the costs.

The UK would like to see similar moves at an EU level and welcomed the high level political commitment to regulatory reform made a Lisbon. The way forward must be impact assessment, the use of alternatives to regulation, minimum standards for consultation, and the review and simplification of existing Community legislation.

Badly drafted regulation can raise the barriers to market entry. The cost of compliance can be a big barrier for entrepreneurs, small firms and growth companies. Encouraging the creation, growth, and survival of these companies must be an important objective for a reforming and progressive EU.

Enabling small firms to grow and ?contest? a market contributes to the achievement of wider economic objectives - like enhancing competition. So we welcome the role played by the European Investment Bank in channelling resources towards growth companies in cutting edge value added sectors and we anticipate further progress with the rapid implementation of the European Charter for Small Enterprises.

Turning from entrepreneurs to innovation?

Research and Development is a key driver of productivity growth. A continual stream of new ideas, new technologies, and new working practices, carries forward the productivity of the EU. Investment in innovation is too low, the EU as a whole lags behind the US and Japan. All Member States must take action to increase the level of R&D spending - dragging the worst up to the level of the best. Tax credits for R&D that encourage companies to invest and capture the public benefits of private research are one way forward.

A recent ECOFIN report also pointed to the importance of:

R&D Framework Programmes - joining up efforts across the EU and beyond;
A low cost easy to obtain Community Patent; and
Reform of the Community State Aid Framework for R&D.

Implementing these recommendations and creating the right atmosphere for innovation will help us achieve our Lisbon objectives - a dynamic, knowledge-based economy.

An effective competition regime, an entrepreneurial culture where risk takers are rewarded and innovations flow through into the markets, low barriers to entry for new firms, and venture capital to help them develop - all of this has important implications for the EU workforce.

So I turn to skills - the fourth driver of productivity growth.

To succeed in flexible labour markets modern workers need the ability to adapt. To succeed in dynamic competitive markets companies need workers with the right skills. To rise to the productivity challenge - the EU needs both. Working together is the key to unlocking the potential of our citizens and the growth potential of the EU.

Training and skills can have a marked effect on productivity. On some measures the productivity gap between the UK and Germany would be wiped out if we could close the skills gap - and other Member States are also starting from a low position.

An EU capable of sustaining economic growth with more and better jobs and greater social cohesion must mean an EU with flexible labour markets, increased labour force participation, and highly skilled workers capable of adapting to the shifting demands of modern markets. As Rodrigo Rato has said - European public opinion demands more growth from governments, and growth that translates into jobs. In our opinion that requires structural change in markets.?

Employment opportunity for all means labour market reform. Not the wholesale adoption of US style flexibility, but the adoption of responsive mechanisms consistent with Member States preferences for different social welfare, labour, and wage bargaining systems.

In the run up to Lisbon Member States labour markets were already beginning to adapt, becoming more responsive to economic growth. We have made progress since Lisbon with a large increase in employment. At Barcelona we need to carry that process forwards, remove the structural barriers to job creation and, because flexible labour markets increase uncertainty for many workers, recognise a commensurate duty to offer our citizens the opportunity to retrain, learn new skills, and access employment opportunity.

Reformed labour markets make social sense and they make economic sense. They make social sense because unemployment across the EU is too high and is a major source of social exclusion. They make economic sense because flexible labour markets respond more quickly to the demands of the wider economy and promote higher levels of growth.

Of course there is no one size fits all model and neither should we seek to impose one. Member States are at different stages of development and have different preferences over their social model - each requires a different approach. Taking tailored approaches, we can all move in the same direction, towards:

Active labour market policies - where the UK still has a lot to learn from our European partners;
Decent minimum standards for those who are in work; and
Support for those who cannot.

These are the steps necessary to create a new, distinctively European framework for labour markets - combining social justice with efficiency - cohesion with growth.

Flexible dynamic markets, the creation of new companies, the development of existing ones, higher levels of research and development, behind each of these objectives stands the European capital market - the final area I wish to address. It was incomplete at Lisbon, it is incomplete today.

The Spanish Presidency have said that ?Full liberalisation and integration of the capital market is a priority; like the rest of the EU, Spain attaches importance to integrating and liberalising financial markets so as to progress with the completion of the single market and? to boost growth and job creation in our economies.?

The successful completion of an integrated capital market is intimately linked to each of our other economic objectives and to the ultimate goal of higher levels of growth and a better quality of life for all of our citizens. Progress to date has been disappointing, firms and consumers across the EU have paid the price. At Barcelona and beyond we must turn good intentions into solid actions.

An integrated financial marketplace would allocate capital more efficiently; allow better diversification of risk; be more competitive, and hence more innovative and lower-cost for a broader range of borrowers and investors; enjoy economies of scale; and be better placed to win ?export? market share outside the EU.

All the evidence suggests a strong causal link between competitive capital markets, investment, and growth.

To boost the levels of investment and increase productivity in the EU we need to increase the efficiency of our market mechanisms. Our shared objective must be to create an effective and dynamic financial services market that will efficiently link sources of capital - investors and savers - to users of capital - firms and individuals seeking to raise finance. We must aim to reduce the costs of accessing capital, narrow the margins between savers and borrowers, and increase the efficiency of its allocation across the EU.

Broadly speaking, that means concentrating on priorities in the Financial Services Action Plan, developing and publishing output orientated indicators of success, and speeding the process of integration through mutual recognition - allowing healthy regulatory competition within a framework of integration.

The focus for the next few months must be on:

Lamfalussy - getting the framework right;
Pensions - removing the barriers to the development of occupational schemes; and the
Prospectus Directive - lowering the cost of capital.

The Lamfalussy report provides the framework for the reform of the EU's securities markets. Prioritising directives that would bring the biggest economic benefits, emphasising consultation and transparency in the drafting of legislation, and arrangements to speed up the passage of directives, can only enhance the integration of the EU's securities markets.

Now the Commission and EP have overcome their differences regarding secondary - "comitology" - legislation, we need to move swiftly to capture benefits of the Lamfalussy approach. Comitology is a potentially powerful tool but it must be used within an overarching framework of objectives for EC securities legislation. This would ensure that Directives are focused on bringing about beneficial economic outcomes and do not promote regulation for its own sake.

Each individual Directive should set out the principles to be followed to achieve these outcomes. Within the framework of principle set by each Directive, comitology should be used to fill in the detail currently found on the face. By setting out the uses and abuses of comitology clearly at the outset we will enable legislation to respond to changes in fast-moving markets while still remaining true to the principles set out by the Council and Parliament.

Our overarching objective must be to cut the cost of accessing capital for EU firms, especially SMEs. We need to ensure that priority measures currently under discussion deliver this outcome.

One of these priorities is the Prospectus Directive. We need an outcome that provides an effective passport for issuers - lowering the cost of accessing capital for firms across the EU, and making the capital market more efficient and liquid, whilst ensuring that there is an appropriate level of protection which distinguishes between professional and retail investors. Legislation must seek to capture and support the valuable diversity of market types and business needs. I hope that we can work collectively to ensure that the directive helps us achieve these objectives. A directive that raises the cost of capital would be a very strange outcome.

There also seems to be some confusion over the purpose of the supplementary pensions directive. It should be about delivering the mutual recognition necessary to remove barriers to the operation of occupational schemes on a cross-border basis. It is not, and must not become, an attempt to interfere with the structure of Member States? pension systems.

The goal is to deliver decent pensions for citizens at the lowest possible cost to firms and employees. Here again the link between the financial services agenda and the objectives of economic reform are clear. Pensions are a significant part of non-wage labour costs. To meet the Lisbon target of 20 million new jobs by 2010 we have to ensure that pension regulation has the effect we want - affordable pensions and increasing employment opportunities - not one at the expense of the other.

That means a new way of thinking about our approach to regulation. In the financial markets mutual recognition not harmonisation must be the way forward.

Across the entire economic reform agenda it is, in part, the shibboleths of legislation and harmonisation that are holding up the process of integration. The construction of the Single Market inevitably entailed a massive amount of Community legislation, but times have changed and our methods must change with them. In the vast majority of areas covered by the Lisbon agenda it is nation states that must take responsibility for putting their own house in order - taking different, tailored, approaches to achieving the same economic and social goals.

The way forward must be through guidelines, indicators, and mutual recognition, not rules, stipulation, and harmonisation. This is the open method of co-ordination - faster, slicker, and more flexible than the traditional approach.

In the light of recent events the need to pursue the agenda of European economic reform has acquired a greater, not lesser, urgency and so the argument for the open method has grown stronger. The slowdown in the world economy and the introduction of the euro in the twelve Member States are an incentive to get on with the job - not to slow it down with unnecessary and ill-conceived attempts at legislation.

The Lisbon agenda is not just for the good times; it is for the bad times as well. Flexible, dynamic economies are better placed to withstand difficulties. They have shallower recessions and they recover from them faster.

We are in a synchronised slowdown and we have a shared responsibility - along with the USA, Japan, and the other industrialised economies - to put the world back onto a productive path. Speed is of the essence, and I am sure that Heads of State and Government, meeting at Barcelona later this week, will recognise that fact.

Thank you.

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